Market Forces of Supply and Demand Notes

Lecture Objectives

  • Define and identify factors determining consumer behavior (demand).

  • Understand the graphical representation of demand.

  • Define and identify factors determining seller behavior (supply).

  • Understand the graphical representation of supply.

  • Identify conditions for market equilibrium and its implications.

  • Textbook: Chapter 4 - The market forces of supply and demand

The Market Forces of Supply and Demand

  • Supply and demand are fundamental concepts in economics.

  • They drive market economies.

  • They determine the quantity and price of goods.

  • To understand economic impacts, consider supply and demand.

Markets and Competition

  • Supply and demand reflect interactions in markets.

What is a Market?

  • Market: A group of buyers and sellers for a particular good or service.

    • Buyers determine demand.

    • Sellers determine supply.

What is Competition?

  • Competitive Market: Many buyers and sellers, each with a negligible impact on market price.

    • Price and quantity are determined by their interactions.

Perfect Competition

  • Markets are assumed to be perfectly competitive in this chapter.

  • Goods are identical.

  • Numerous buyers and sellers, none can influence the market price.

  • Buyers and sellers are price takers.

At the Market Price

  • Buyers can buy as much as they want.

  • Sellers can sell as much as they want.

  • Not all markets are perfectly competitive.

Other Market Structures

  • Monopoly: Only one seller who sets the price (example given).

  • Other markets fall between perfect competition and monopoly.

Demand

The Demand Curve: The Relationship Between Price and Quantity Demanded

  • Quantity demanded: The amount buyers are willing and able to purchase.

  • Law of demand: Other things being equal, quantity demanded falls when the price rises.

Demand Schedule and Curve

  • Demand schedule: A table showing the relationship between price and quantity demanded.

  • Demand curve: A graph of the relationship between price and quantity demanded.

Catherine's Demand Schedule and Demand Curve

  • Example provided with a table and curve illustrating the inverse relationship between the price of ice-cream cones and the quantity demanded.

  • A decrease in price increases quantity of cones demanded.

Market Demand Versus Individual Demand

  • Market demand: The sum of all individual demands for a good or service.

Market Demand as the Sum of Individual Demands

  • Market demand is derived by horizontally summing individual demand curves (Catherine and Nicholas example).

  • Any change affecting quantity and/or price demanded translates to either of the two movement/change on demand curve:

    • Shifting the demand curve to right or left, or

    • Movement along the demand curve with no shift!

Shifts in the Demand Curve

  • Increase in demand: Shifts the demand curve to the right.

  • Decrease in demand: Shifts the demand curve to the left.

Factors That Shift the Demand Curve:

  • Income:

    • Normal good: Increase in income leads to an increase in demand.

    • Inferior good: Increase in income leads to a decrease in demand.

  • Prices of related goods:

    • Substitutes: Increase in the price of one leads to an increase in the demand for the other.

    • Complements: Increase in the price of one leads to a decrease in the demand for the other.

  • Tastes

  • Expectations

  • Number of buyers

Shifts in the Demand Curve versus Movements along the Demand Curve

  • A shift in the demand curve is caused by a change in a non-price determinant of demand.

  • A movement along the demand curve is caused by a change in the price of the good itself.

  • Example using cigarettes: a policy discouraging smoking shifts the demand curve, while a tax on cigarettes causes a movement along the demand curve.

Active Learning on Demand Curve

  • Example: Music Downloads

    • A. The Price of iPods Falls

      • Music downloads and iPods are complements.

      • A fall in the price of iPods shifts the demand curve for music downloads to the right.

    • B. The Price of Music Downloads Falls

      • The demand curve does not shift.

      • Move down along the curve to a point with lower price, higher quantity.

    • C. The Price of CDs Falls

      • CDs and music downloads are substitutes.

      • A fall in the price of CDs shifts demand for music downloads to the left.

Supply

The Supply Curve: The Relationship Between Price and Quantity Supplied

  • Quantity supplied: The amount that sellers are willing and able to sell.

  • Law of supply: Other things being equal, the quantity supplied rises when the price of the good rises.

Supply Schedule and Curve

  • Supply schedule: A table showing the relationship between price and quantity supplied.

  • Supply curve: A graph of the relationship between price and quantity supplied.

Ben's Supply Schedule and Supply Curve

  • Example provided with a table and curve illustrating the direct relationship between the price of ice-cream cones and the quantity supplied.

  • An increase in price increases quantity of cones supplied.

Market Supply Versus Individual Supply

  • Market supply: The sum of the supplies of all sellers.

Market Supply as the Sum of Individual Supplies

  • Market supply is derived by horizontally summing individual supply curves (Ben and Jerry example).

Shifts in the Supply Curve

  • Increase in supply: shifts the supply curve to the right.

  • Decrease in supply: shifts the supply curve to the left.

Factors That Shift the Supply Curve:

  • Input prices

  • Technology

  • Expectations

  • Number of sellers

Supply and Demand Together

  • Supply and demand are combined to determine the price and quantity of a good sold in the market.

Equilibrium

  • Equilibrium: A situation where the price has reached the level where quantity supplied equals quantity demanded.

Equilibrium Price and Quantity

  • Equilibrium price: Balances quantity supplied and quantity demanded.

  • Equilibrium quantity: The quantity supplied and demanded at the equilibrium price.

Markets Not in Equilibrium

  • Surplus: Quantity supplied is greater than quantity demanded.

  • Shortage: Quantity demanded is greater than quantity supplied.

Law of Supply and Demand

  • The price of any good adjusts to bring the quantity supplied and the quantity demanded into balance.

Impact on Equilibrium from Some Event

  • Analyzing the impact of an event on market equilibrium involves three steps.

Examples

  • Analyzing the change in equilibrium (price and quantity) in the market for ice cream from:

    1. Increase in weather temperature

    2. Increase in the price of sugar

    3. Both (1) and (2)

How an Increase in Demand Affects the Equilibrium

  • Hot weather increases the demand for ice cream, resulting in a higher price and a higher quantity sold.

How a Decrease in Supply Affects the Equilibrium

  • An increase in the price of sugar reduces the supply of ice cream, resulting in a higher price and a lower quantity sold.

A Shift in Both Supply and Demand

  • The effect on equilibrium price and quantity depends on the relative magnitude of the shifts in supply and demand.

Conclusion: How Prices Allocate Resources

  • Market economies use supply and demand to allocate resources.

  • Prices determine the allocation of resources.

Lecture Practice

  • 1. Suppose we have the following market supply and demand schedules for bicycles:

    • Price

    • Quantity Demanded

    • Quantity Supplied

    • $100

      • 70

      • 30

    • 200

      • 60

      • 40

    • 300

      • 50

      • 50

    • 400

      • 40

      • 60

    • 500

      • 30

      • 70

    • 600

      • 20

      • 80

      • 1.1. Plot the supply curve and the demand curve for bicycles.

      • 1.2. What is the equilibrium price of bicycles?

      • 1.3. What is the equilibrium quantity of bicycles?

      • 1.4. If the price of bicycles were $100. Is there a surplus or a shortage? How many units of surplus or shortage

      • are there? Will this cause the price to rise or fall?

      • 1.5. If the price of bicycles were $400, is there a surplus or a shortage? How many units of surplus or shortage

      • are there? Will this cause the price to rise or fall?

      • 1.6. Suppose that the bicycle maker's labor union bargains for an increase in its wages. Furthermore, suppose

      • this event raises the cost of production, makes bicycle manufacturing less profitable, and reduces the

      • quantity supplied of bicycles by 20 units at each price of bicycles. Plot the new supply curve and the original

      • supply and demand curves. What is the new equilibrium price and quantity in the market for bicycles?

Appendix: The Mathematics of Market Equilibrium

  • The linear demand curve:

  • The slope of the demand curve is:

  • The linear supply curve:

  • The slope of the supply curve is:

  • Equilibrium price is found by setting: QS = QD

  • To determine the equilibrium quantity demanded in the market, substitute the equilibrium price into the equation for quantity demanded to get:

  • To determine the equilibrium quantity demanded in the market, substitute the equilibrium price into the equation for quantity demanded to get: